FIN 486 Week 4 Value Creation for Stakeholders Example

Fix, Sell or Close the Custom Line? Weighing Shareholders, Workers, Customers and a Wisconsin Town in Lakeshore Packaging's Hardest Decision, and Setting a Payout Policy

[Student Name]

University of Phoenix

FIN/486: Strategic Financial Management

Week 4 Assignment

[Instructor Name]

[Date]

Lakeshore Packaging, its plants and all figures are composites written for a model paper; theories and research findings come from the sources listed.

Lakeshore Packaging's custom line, which makes molded fiber inserts for electronics and cosmetics, ties up about $190 million of capital and earns about 4.5 percent on it, against an 8.6 percent cost of capital, destroying about $8 million of value a year. Most of the line's work is done at a 260-worker plant in Fond du Lac, Wisconsin, the town's third-largest employer. A private equity firm has offered $150 million for the line, and some directors want to close the plant and move the remaining work elsewhere. The numbers favor ending the drain, but how Lakeshore ends it will be judged by its workers, its customers and a town that has known it for forty years. This paper evaluates the options and the payout policy that follows.

Measuring Value

Economic value added, developed by Stewart (1991) as a practical measure of economic profit, charges each business for the capital it uses. The custom line's operating profit after tax is about $8.6 million against a capital charge of about $16.3 million, so its economic value added is about negative $7.8 million a year. Value creation requires raising its return above the cost of capital, shrinking the capital it uses or transferring it to an owner who can do better with it.

Option One: Fix It

Management proposed to keep only high-volume custom programs, end low-margin small orders, standardize mold designs and price new work to reflect setup costs. Consultants estimated this would cut revenue from $165 million to about $120 million and capital from $190 million to about $130 million, though selling idle molds and equipment would recover only about $25 million in cash, with restructuring costs of about $15 million. If the plan worked, the return would reach about 8.8 percent within three years, roughly the cost of capital, so economic value added would move from about negative $8 million to about zero. Consultants gave the plan about a 60 percent chance of full success. It would also eliminate about 70 jobs through attrition and transfers.

Option Two: Sell It

The $150 million offer compares with the line's value as a going concern under current performance, about $100 million when its after-tax operating profit is capitalized at the cost of capital, and its expected value under the fix plan, about $130 million after cash recovered, restructuring costs and the chance of failure. Selling captures more than either, because the buyer plans to combine the line with a similar business. The buyer committed to keep the Fond du Lac plant open for at least three years.

Option Three: Close the Plant

Closing Fond du Lac and moving remaining custom work to other plants would free capital quickly but would cost about $28 million in severance, cleanup and contract penalties, leave 260 workers without jobs in a town of 44,000 and strain relationships with electronics and cosmetics customers who also buy food service packaging. Its value to shareholders, after costs and lost cross-selling, is below the sale.

The Shareholder View

Friedman (1970) held that a business serves society best by earning as much as it legally and honestly can, leaving social goals to individuals and governments. Under this view, Lakeshore should choose the option worth most to shareholders, which is the sale.

The Stakeholder View

Freeman (1984) urged managers to weigh every group whose support the firm needs or whose lives it changes, because the firm's success depends on them. Workers, customers and the town have legitimate interests: continued employment, reliable supply and a stable tax base.

Reconciling the Two

Jensen (2001) argued that firms cannot maximize several objectives at once, but that long-run value can only be maximized by treating stakeholders well, since their cooperation affects future cash flows. Edmans (2011) found that companies listed among the best places to work earned higher long-run stock returns than their peers, suggesting that markets underestimated the value of treating employees well. For Lakeshore, how the line is exited affects the trust of workers at its other plants, the confidence of customers and its reputation in Wisconsin, all of which bear on long-run value.

The Recommendation

Lakeshore should accept the sale, which creates the most value for shareholders, and negotiate terms that serve other stakeholders: an extension of the buyer's plant commitment to five years, the transfer of all employees with their seniority and benefits, a supply agreement under which Lakeshore continues to serve shared customers' food service needs and a transition period for customer programs. Those terms may cost a few million dollars in price but protect relationships that matter to the rest of the business.

Payout Policy

The sale will bring about $150 million in cash. The Georgia plant and its working capital are already funded through debt and internal cash, and phase two may need capital in four years. Lintner (1956) found that managers set dividends conservatively and adjust them slowly toward a target share of earnings, avoiding cuts. Brav et al. (2005) found that modern managers still treat dividends as a near-fixed commitment while using repurchases flexibly. Lakeshore will raise its regular dividend by 8 percent, a level it can sustain, use $60 million to reduce debt toward the middle of its target range and repurchase about $50 million of shares over two years, pausing if net debt rises above 2.5 times EBITDA.

Communicating the Decision

Employees in Fond du Lac will hear the decision from Lakeshore's chief executive in person before any public announcement. Customers will receive transition plans. Investors will hear how the sale raises return on invested capital for the remaining company.

Conclusion

The custom line destroys value, and among three options the sale captures the most for shareholders. Negotiating protections for workers, customers and the town reflects Jensen's view that long-run value depends on stakeholder trust, supported by evidence that treating employees well pays. Proceeds fund a sustainable dividend increase, debt reduction and flexible buybacks.

References

Brav, A., Graham, J. R., Harvey, C. R., & Michaely, R. (2005). Payout policy in the 21st century. Journal of Financial Economics, 77(3), 483-527. https://doi.org/10.1016/j.jfineco.2004.07.004

Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices. Journal of Financial Economics, 101(3), 621-640. https://doi.org/10.1016/j.jfineco.2011.03.021

Freeman, R. E. (1984). Strategic management: A stakeholder approach. Pitman.

Friedman, M. (1970, September 13). The social responsibility of business is to increase its profits. The New York Times Magazine, 32-33, 122-126.

Jensen, M. C. (2001). Value maximization, stakeholder theory, and the corporate objective function. Journal of Applied Corporate Finance, 14(3), 8-21. https://doi.org/10.1111/j.1745-6622.2001.tb00434.x

Lintner, J. (1956). Distribution of incomes of corporations among dividends, retained earnings, and taxes. The American Economic Review, 46(2), 97-113.

Stewart, G. B. (1991). The quest for value: The EVA management guide. HarperBusiness.